With thousands of stocks to choose from, investing can seem daunting. How do you pick the winners from the losers? True, you can simply buy an index fund and bet that business in general will improve, but in doing this you wind up buying the losers along with the winners. So while it may be difficult, it is worth taking the time to sort out the winners to add to your portfolio.
The following three tips should make this easier. If an investment satisfies these conditions, I believe that it will have a much higher likelihood of generating superior long-term returns. Keep in mind that this isn’t a guarantee — there is nothing certain in investing and the best we can do is put the odds in our favor. But if you know how to do so, you will almost certainly be a successful investor.
1. Look for companies with wide economic moats
An economic moat is an attribute that a company has that makes it very difficult for other companies to compete with it. For instance, a company can own a patent (e.g. a drug company), a well-known brand [e.g. Coca Cola (NYSE:KO)], or it may simply own a business that requires a lot of infrastructure and land that is virtually impossible to replicate (e.g. rail-transport companies.) Companies with wide economic moats are virtually impervious to competition, and as a result, managements have one less thing to worry about when it works toward generating shareholder value.
Investors should keep in mind that not all economic moats are the same, and that some are wider than others. For instance, brand loyalty can be fickle, and so except in a few cases, brand moats are not as wide as, for instance, land and infrastructure moats. As an investor, you should analyze a company’s moat and as yourself what it would realistically take to compete with it. If you can easily come up with an answer that doesn’t require much capital and which falls within the realm of probability, then that company probably doesn’t have a wide moat.